How safe are safe haven assets?

03 February 2020 | Investment principles

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When it comes to securing "safe" assets, it seems some will go to extraordinary lengths.

In the early hours of 14 September last year, burglars broke into Britain's Blenheim Palace, the birthplace of Sir Winston Churchill, and stole America – an 18-carat gold lavatory created by US conceptual artist Maurizio Cattelan.

Although a fully functioning art exhibit, there's little doubt the real value for the perpetrators was its weight in gold. At 1,600 ounces, and based on the current gold price, it would be worth around $US2.5 million once melted down.

Which is what may have occurred because, while UK police have apprehended several of those involved, America is yet to be found.

The gold effect

Gold is often referred to as the classic "safe haven" asset because its price can't be controlled or manipulated by any single investor or government.

It also has a unique status as being both a store of wealth in its physical form as a precious metal, and because it can easily be used as a global currency in its own right (in raw, bullion or jewellery form) or exchanged into cash.

The gold price rose close to 18 per cent last year, thanks to strong investment inflows. Those inflows corresponded with widespread nervousness on markets related to the US-China trade war, Brexit and other geopolitical uncertainty, because gold is used as a hedge against broader economic and financial markets volatility.

Yet, gold is not totally immune from volatility. Its price rises and falls on a daily basis based on supply and demand, which is driven by investors including central banks as well as jewellery manufacturers and retail consumers.

And, although not strictly correlated with equity markets, listed gold producers and explorers, and listed fund products with either physical or synthetic gold holdings, are directly connected to the daily movements of the gold price.

Sharp movements in the gold price, up or down, will invariably flow through to listed gold companies and funds, which can then influence investor sentiment across broader markets.

So, there's not necessarily total safety in holding physical gold or gold-associated equities given the vagaries of the gold market itself, plus it also should be noted that, unlike equities or fixed income, gold as a metal cannot generate an income stream.

Back to basics

The basic needs approach for humanity has three core elements: food, clothing and shelter.

On an investment level, the companies providing these elements and extended forms of these human essentials – electricity, water, transport, communications and medical services – are considered safe havens because they are not discretionary.

That is, irrespective of investment conditions, demand for basic products and services will continue to be part and parcel of everyday living.

However, while often considered as defensive, these companies are not necessarily safe havens.

It's important to recognise that all companies, regardless of sector, are always exposed to economic forces, market competition and other external factors, such as government regulations.

Hence, it's vital to undertake due diligence on a range of levels rather than assuming that any company providing essential services or delivering basic needs will always be a safe haven investment.

Low-risk assets

There is an element of risk in any investment, although assets at the bottom end of the risk scale are often regarded as safe havens because they are less susceptible to financial shocks than those further up the risk scale.

In turn, lower risk invariably translates to lower returns – although this is not always the case.

Among the lower-risk assets are fixed income securities such as government-backed debt instruments, including Treasury bills and fixed-rate bonds, because investors choosing to hold on to their initial investment until maturity will be repaid in full and also be paid regular interest payments along the way. The key risks with these safe havens is potentially locking away capital for long periods of time and missing out on higher income from other asset classes, and the risk of selling before maturity and facing a capital loss if the trading value of the security has fallen below the initial investment price.

When investors think of safe haven assets, often the first thing that springs to mind is cash. Physical cash is essentially untouchable, and cash holdings in authorised deposit taking institutions' accounts up to the value of $250,000 are guaranteed by the Federal Government.

"Cash is king" is a phrase that has been widely used over time, including immediately after the 1987 stock market crash and during the more-recent Global Financial Crisis.

But those who cashed out of equity markets as a result of either event would have suffered a huge opportunity cost, unless they reinvested their capital quickly in time to ride the huge stock market rebounds that followed. Trying to time markets is a high-risk strategy.

An analysis of recent Australian Tax Office data shows self-managed superannuation funds on average have 21 per cent of their assets in cash, and smaller funds on average have more than 40 per cent.

Cash is certainly a safe haven, but having too much exposure is also an investment trap based on current cash returns of 1.5 per cent per annum or less, which are well below the inflation rate.

Safety in diversification

Safe havens assets can serve a purpose in sheltering from market storms, but having an investment strategy with a long-term focus that incorporates a broad range of assets is ultimately the safest harbour.

Such a strategy avoids kneejerk responses to markets volatility, including sudden large switches of capital between asset classes in an effort to time market rises and falls.

Having diversified exposures across different asset classes and regions, focusing on reducing investment costs, and having a disciplined approach aligned to your specific financial goals, will help weather market shocks and deliver portfolio growth over the long term.

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Tony Kaye

Tony Kaye
Personal Finance Writer
Vanguard Australia